For Banks, Wads of Cash and Loads of Trouble

A BOOMS LEFTOVERS Once flush with cash, Security Bank in Macon, Ga., built a sprawling new headquarters. As the bank struggles to survive, the office is empty and in need of a tenant.Credit
Tami Chappell for The New York Times

MACON, Ga. — H. Averett Walker used hot money to turn Security Bank from a sleepy Southern lender into a regional powerhouse. Darrell D. Pittard used hot money to jump-start his brand-new MagnetBank, allowing it to lend hundreds of millions of dollars even though it did not have a single drive-up window or even a customer with a checking account.

It is a formula being replicated at banks across the United States.

Rather than simply wooing local customers, they have turned to out-of-state brokers who deliver billions of dollars in bulk deposits, widely known as “hot money,” from investors nationwide. In fast-growing regions like this one in central Georgia, the money produced record bank profits and financed whole new communities, built at a phenomenal rate.

But the hot money also came with a high cost. To lure the money from brokers, banks typically had to offer unusually high rates. That, in turn, often led them to make ever riskier loans, leaving them vulnerable when the economy collapsed. Magnet failed early this year and Security Bank is barely hanging on.

Though few people have heard of it, hot money — or brokered deposits, as it is also known in the industry — is one of the primary factors in the accelerating wave of failures among small and regional banks nationwide. The estimated cost to the Federal Deposit Insurance Corporation over the last 18 months is $7.7 billion, and growing.

Hot money has bedeviled regulators for three decades and they are starting to fight back, albeit tentatively, devising new restrictions to keep the practice from taking more banks down. But in one of the hidden lobbying battles in Washington this year, the banks are pushing hard to keep the money flowing.

So far the banks are winning, and the hot money continues to fuel bank growth. The industry has even invented variants to get around the few rules that have been put in place by regulators.

Banks defend the use of brokered deposits as an important tool to bring in money to help communities grow. But even some industry executives acknowledge that certain banks became too dependent on the deposits, and that this abuse caused banks to fail. The consequences can be seen across the country.

The 79 banks that have failed in the United States over the last two years had an average load of brokered deposits four times the national norm, according to an analysis performed for The New York Times by Foresight Analytics, an industry research firm based in California. And a third of the failed banks, the analysis shows, had both an unusually high level of brokered deposits and an extremely high growth rate — often a disastrous recipe for banks.

The data also shows that the problem isn’t likely to go away. The 371 still-operating banks on Foresight’s “watch list” as of March held brokered deposits that, on average, were twice the norm. Even this year, in the depth of the recession, a number of struggling banks have been piling up hot money in a desperate effort to survive.

It is the same mix — rapid increases in hot money and heavy lending for risky real estate development — that brought down many of the savings and loans in the late 1980s.

Warnings and Resistance

Regulators now acknowledge that they saw the warning signs during the most recent boom, but failed to take aggressive action. “We went through this golden age of banking and I just think that everybody lost their compass,” said Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation.

Their indifference has been costly. Even brokered deposits are insured, up to $250,000 for each customer account. But once a bank fails, these deposits become an albatross to the F.D.I.C., which often looks for a healthy bank to take over the failed bank. Most new owners refuse to accept the brokered money — it doesn’t bring branches or real customers — forcing the F.D.I.C. to repay it. The fight over brokered deposits, though far less public than other struggles over the nation’s regulatory system, is one of many in Washington that will help determine the shape of industries ravaged by the economic crisis.

To make their case, a delegation of nearly 50 Georgia bankers assembled at the F.D.I.C.’s headquarters in May to plead with regulators to ease restrictions on brokered deposits.

“It is a bullet to their head,” Joe Brannen, president of the Georgia Bankers Association, recalled members of the group telling senior agency officials. “This is insanity.”

Brokered deposits, industry players and regulators agree, are not inherently a bad thing. Many institutions have relied on brokered deposits for years without troubles. Without brokered deposits, small regional banks in fast-growing parts of the country would not have been able to keep up with the demand for construction loans.

The brokers receive much of the money from investment firms like Merrill Lynch, which are looking to park high-interest certificates of deposits they have sold to clients. Merrill customers get two things out of the arrangement: high returns on their investments and a haven because the money is placed in a bank insured by the F.D.I.C. One brokerage firm, Finance 500, in Irvine, Calif., started a hot money program in 1997 with seven bank customers. A decade later, it delivered $14 billion to more than 1,500 banks.

But the money is volatile. It can be easily shifted from one bank to another as brokers seek the highest interest rates. Thus the term hot money.

Some banks prosper by supplementing their accounts with these deposits, but try not to rely too much on them because the interest payments are high and the brokers can be fickle. “It’s simple, really,” Michael Hobbs, the chief executive of First Commercial Bank in Missouri wrote to the F.D.I.C. late last year, in defending the industry’s practices. “If brokered deposits are managed accordingly, they provide a safe alternative funding source.”

But William M. Isaac, chairman of the F.D.I.C. from 1981 to 1985, said he became wary nearly three decades ago after watching the spectacular fall of Penn Square Bank of Oklahoma City, which had grown astronomically by gorging on brokered deposits. Alarmed by the practice, Mr. Isaac moved to eliminate F.D.I.C. insurance for most brokered deposits — a rule that provoked an industry revolt and was ultimately overturned. Congress later made a similar attempt, but it too was defeated.

“I have a lot of scars on my back,” Mr. Isaac said in an interview, recalling the fight over the rules. “I don’t have any doubt that tens of billions were lost in the S.& L. crisis because of brokered deposits. And we were on our way to shutting that practice down.”

By 1991, Congress prohibited weak banks from obtaining brokered deposits unless they were adequately capitalized. But because approximately 97 percent of the banks in the United States are considered “well capitalized,” the limit has little impact. Three years later, the F.D.I.C. watered down that rule by repealing the requirement that banks looking to grow rapidly with brokered deposits seek special permission from the agency.

The Frenzy in Georgia

The risks and rewards of brokered deposits played out visibly here in Georgia, where a red-hot real estate market in metropolitan Atlanta drove a lending frenzy that was heavily financed by hot money.

Photo

An upscale new neighborhood called the Highlands remains unfinished.Credit
Tami Chappell for The New York Times

Mr. Pittard built MagnetBank solely on brokered deposits, eschewing even traditional branches. “It was very simple,” he said. “It was clean.” And the F.D.I.C. approved it.

The bank was chartered in Utah, but did much of its lending in Georgia. When the real estate market here turned in 2007, many borrowers fell behind and Magnet began to crumble. Its failure in January 2009 cost the F.D.I.C. an estimated $129 million.

Magnet is the extreme example: 100 percent of its deposits were brokered. The story of Security Bank is more typical of the risks.

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For years it stayed out of the brokered deposit trade. Mr. Walker, its president and chief, who was known to everyone here in Macon as Rett, bragged to the newspaper about how much he valued local customers.

“The more accounts they have with you — from a child’s savings account to a safety deposit box — the more loyal the customer is and less likely to leave,” Mr. Walker said in 2001, the same year he dressed up in a tuxedo shirt and jacket, jeans and boots to cook up a quail dinner for employees at a branch that had met a sales goal.

But even as he spoke, suburban Atlanta was booming, and Security wanted to take advantage.

It bought small banks to ramp up its lending. But that did not satisfy its ambitions, government records show. So, despite Mr. Walker’s faith in small depositors, Security called the brokers.

At the start of the decade, Security held just $693,000 in brokered deposits. By last year it had $798 million, or 33 percent of its overall deposit base.

To attract the wholesalers, Security had to offer interest rates that, as of 2007, averaged 5.28 percent, or 20 percent higher than what local banking customers got.

To generate the profits to pay such rates, Security began concentrating its lending in the riskiest corners of the market: acquisition of raw land and construction of housing developments. These loans can bring higher profits from fees and higher interest rates. In 1999, construction lending was 8 percent of Security’s loan portfolio. By 2007, it peaked at 53 percent, including prominent projects like converting 230 acres of a former plantation into an upscale new neighborhood called the Highlands.

For a while, the hot money strategy seemed to be working; Security’s profits soared, as did its stock price. Then the economy went sour. Now Mr. Walker has been forced out of his job, and the bank acknowledges it is struggling to survive. It built itself a sprawling new headquarters here in Macon, but it is no longer putting its name atop the tower. Instead, it is trying to find someone to lease the empty space. The Highlands project, like many others it financed, sits unfinished.

Thomas D. Woodbery, the bank’s senior vice president, defended the strategy as a “proven and reliable” way to get more money for loans. But he said the bank was now reducing its allowance on brokered deposits — under orders from the F.D.I.C., which only in April placed heavy restrictions on Security by issuing a cease-and-desist order.

Through this hot-money explosion, the regulators largely watched from the sidelines, offering warnings at times, but declining to intervene forcefully, officials in Washington now acknowledge. The F.D.I.C. allowed many banks that lost their “well capitalized” status to keep taking brokered deposits, approving waivers for about 65 percent of the applicants over the last five years.

“Don’t get in the way, don’t take away the punch bowl,” Ms. Bair said, describing the approach taken by regulators, including her own agency.

Regulation Battles

At the Office of the Comptroller of the Currency, part of the Treasury Department, bank examiners in 2005 found that ANB Financial of Arkansas relied heavily on brokered deposits to fuel rapid growth, an audit shows. Yet the regulators did not take “forceful action” for two more years, the audit says, just before ANB was shut down.

At the Office of Thrift Supervision — a Treasury agency that President Obama wants to eliminate — regulators advised BankUnited of Coral Gables, Fla., to backdate financial records, allowing it to continue to lure brokered deposits, the department’s inspector general reported in May 2009.

In recent years, even some brokers became concerned about the dependence on hot money that certain banks had developed, said Paul T. Clark, an industry lawyer in Washington. They shared those concerns with regulators at the F.D.I.C. last year, hoping to head off a crackdown. “We looked at this and we were very nervous,” he said. “We are going to get blamed because these banks failed. It is not our fault. Where were the regulators?”

Looking back on the reluctance to slow the growth, Timothy W. Long, chief national bank examiner in the comptroller’s office, asked: “When do you tap on the brakes versus slamming on the brakes? It is a hard thing to do sometimes, particularly when management is pushing back hard.”

Late last year, the F.D.I.C. proposed a new rule. Banks that rely too heavily on brokered deposits to accelerate their growth will have to pay a higher insurance premium to help cover losses if they fail. The proposed limit was 10 percent brokered deposits and a growth rate of 20 percent over four years.

Just as it did in the early 1980s, industry opposition emerged almost overnight.

“Brokered’ is not a 4-letter word!” Dennis M. King, chief credit officer of North County Bank in Washington State, wrote in one of hundreds of letters the agency received condemning Ms. Bair’s plan. “They are especially important to community banks in our present economic environment.”

The banks won important concessions. The regulator relaxed the part of the rule that required higher premiums if banks grew too fast with brokered deposits, allowing a growth rate of up to 40 percent over four years. And it left open a loophole that lets banks — even those considered unsound — turn to a “listing service,” a source of hot money by another name. Instead of paying a broker, banks pay to subscribe to an electronic bulletin board of credit unions with money to park.

One listing service, QwickRate, based in Marietta, Ga., has just 18 employees crammed into a tiny second-floor office. But it delivered $1.6 billion in hot money to banks in May, up from $450 million last May. The growth is coming partly because banks on the edge of failure are coming to the service for a lifeline.

Bank regulators are just learning how popular these unregulated services have suddenly become — and are already worried that they will be the next source of hot money abuses.

Ms. Bair said she planned to ask Congress for greater powers to limit the role of hot money in banking — be it brokered deposits, listing services or simply Internet sales by banks offering unusually high interest rates.

“We have seen the error of our ways,” she said.

A version of this article appears in print on , on Page A1 of the New York edition with the headline: For Banks, Wads of Cash and Loads of Trouble. Order Reprints|Today's Paper|Subscribe